THE IMPOSSIBLE DREAM: FREE MARKETS IN MOSCOW

Presented at the Seminar on Futures & Options,
USSR Council of Ministers on Food and Procurement,
Moscow, USSR,
November 1, 1990.

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The most significant part of this address was where it was delivered. Had anyone suggested a year earlier that I would be standing in an open forum in the Soviet Union delivering a speech about market-driven economic order, I would have counseled that they seek medical assistance.

The idea that representatives from the Chicago Mercantile Exchange and the Chicago Board of Trade—the embodiment of free markets—would be invited in 1990 as honored guests of the city of Moscow and the Federation of Russia, was so unbelievable as to be nothing short of science fiction.

The words I used were substantially the same as those I had used countless of times before to countless audiences—but always in the free world. For the first time in modern history, or perhaps even the first time in history, someone was flagrantly preaching to a very large audience in Moscow—in the shadows of the Kremlin—that the only Messiah for the Soviet people was capitalism.

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Two months ago, on August 22, 1990, the Chicago Mercantile Exchange (CME) announced its plans to prepare for an eventual futures contract on the Russian Ruble. It represents a new and dramatic chapter in the revolutionary history that began some eighteen years before. Indeed, the birth of the CME's International Monetary Market (IMM) on June 16, 1972 is symbolic of the power of an idea whose time had come—an idea that has caused fundamental changes in the financial landscape of the world, and one that is intertwined with events in the Soviet Union and every corner of the globe. An idea that recognized that the structural changes in financial markets as a consequence of the telecommunications revolution would make traditional market concepts obsolete—that they would disintegrate market barriers resulting from geographical borders; and that they would demand bold and new financial risk management tools. Indeed, University of Chicago Professor Merton Miller, the 1990 Nobel laureate in Economics proclaimed that financial futures are "the most significant financial innovation of the last twenty years."

That financial futures have become an integral component of the world's financial markets can be evidenced by the futures exchanges in London, Paris, Hong Kong, Sydney, Toronto, Singapore, Brazil, Osaka, Zurich, Frankfurt and Tokyo. Futures markets are symbolic of the economic order that demonstrated its supremacy over an economic system whose structure and function was dependent on central economic controls. Indeed, there are few better examples of price discovery as a consequence of the free forces of supply and demand than the markets of futures and options. Their indispensability to the structure of a market-driven economy was quickly recognized by none other than President Mikhail Gorbachev as he called for the immediate creation of securities and commodity exchanges in the Soviet Union. We applaud this sentiment as well as the recently announced revolutionary steps of your government in the difficult journey toward economic reform.

Not only do futures markets exemplify the infra-structure of a market-driven economy, but the very same technological advancements that gave rise to their birth are the same that made Perestroika inevitable. Indeed, the telecommunications revolution of the last several decades—or what former Citicorp Chairman Walter Wriston called the information revolution—made it impossible to continue the charade and hide the uncompromising truth that an economy dependent on government edict was doomed to failure. Modern communications techniques, coupled with massive media penetration in disregard of national boundaries, offered a stark, unyielding comparison of economic systems. As journalist Mike O'Neil predicted years before the 1989 historic events in Eastern Europe: the consequences of the new telecommunications technology "is hurrying the collapse of old order, accelerating the velocity of social and political change, creating informed and politically active publics, and inciting conflict by publicizing the differences between people and nations."

As it has throughout the history of mankind, technology again dictated fundamental change in the world's social structure and reshaped both the political and economic landscape of our planet. Its immediate impact on the populations of Russian and Eastern Europe is now an historical reality. And Messrs. Gorbachev and Yeltsin both understand the same fact as Federal Reserve Board Chairman Alan Greenspan, namely that: The acceptance and growth of financial futures is the consequence of a need in our volatile world for a cost-efficient market mechanism with which to discover price and hedge financial risk.

However, if anyone in the Soviet Union believes that financial futures can instantly reform your current economic status into a vibrant, successful market-driven economy—or if anyone in the Soviet Union or re-emerging nations of Eastern Europe believe that once securities or futures exchanges are created within your respective borders they will instantly transform stagnant economic conditions into prosperous standards of living for all—allow me to quickly persuade you that this is not the case. Indeed, nothing can be further from the truth. Nothing can serve to impede your journey to economic success more than the mistaken belief that there is an instant solution—for one does not exist. The road to economic success is painful, long, extremely difficult, and laden with pitfalls that can delay the process, divert you in a wrong direction, or lead you toward a dead end. To be perfectly blunt, conditions here will get much worse before they get better—but there is no other choice.

While they have their differences, Messrs. Gorbachev and Yeltsin both recognize the efficiency of a market economy; that the prerequisite to the effective functioning of the market includes the right of private property, the shift from government to private ownership of assets, the restructuring of the banking system to create a central bank independent of the government, the need for commercial banks to be independent of the central bank, and to create a single convertible national currency. These are the fundamentals upon which the road to a free market economy can successfully be built. And while none of these can be accomplished overnight, there will be stages. For instance, the recent announcement that four exchange rates will soon be established for the Ruble are encouraging—if they will in fact take place:

1) A commercial rate of 1.8 Ruble to the Dollar, for all trade and investment transactions. This will replace the complex and antiquated system of about 2000 different so-called co-efficient. The new system will undoubtedly encourage exports as it is intended.

2) The official rate of .56 Ruble to the Dollar for international statistical comparisons and for calculating payment by developing countries on Ruble-denominated debt.

3) The market rate to be set by new exchanges which will become operational in Moscow and other cities and be open twice a week for foreigners to use for their profit conversion to hard currency. This step in particular is of critical relevance in establishing a fully convertible Ruble.

4) A tourist rate of 6.2 Rubles to the Dollar for Russian citizens who intend to travel abroad by virtue of the newly-liberalized immigration law.

However you achieve it, through slow stages or through a more painful rapid mechanism, ultimately there must be a single, fully convertible rate for the Ruble—one that can meet the fair market test on the international arena—for only then can the Ruble be convertible.

This plan recognizes the critical Soviet need for foreign investment capital. To rely solely on foreign government loans to bolster your economy would be a serious mistake—indeed because the United States today finds its own economic house in disorder, our flow of government funds to the Soviet Union will be limited. Consequently, it is imperative that foreign private sector capital be sought. To accomplish this result, it is mandatory that current restrictions on exporting profits be dropped and that foreign investors know how to calculate their rate of return. Therefore, the announced Ruble plans are essential elements in the journey to a market economy, and while such moves are fraught with the danger of enormous inflation and pain for the average citizen, they are steps that cannot be avoided. In this respect, the Chicago Mercantile Exchange will carefully monitor the results as we attempt to determine at which point we can assist the process by instituting a viable futures market in the Ruble.

I am heartened by conversations with Sergei Stankevitch, Gennady Poleshuk and Vladimir Paplauski and have a great deal of faith in their intellect. I respect their basic understanding of futures markets. The statements of your Mayor, the Honorable Gavriil Popov, are refreshing and encouraging for he is not only an advocate of a market economy, but is providing the infrastructure to encourage its implementation. The Moscow Commodity Exchange is but one significant example of his efforts. And while the Moscow Commodity Exchange may not, at its inception, look or trade in the same manner as do the Chicago markets—indeed its wares of physical commodities are very different from our financial indexes and intangibles— nevertheless, this exchange represents the all important beginning. I salute you for this first milestone.

While the world is cognizant of the 500 Day Plan approved on September 11 by the Parliament of the Russian Republic, we are also aware of the philosophical differences that exist regarding the rapidity by which the intended reforms can occur—issues such as decollectivizing farming and the restructuring of farm land from state to private ownership, and issues such as tax collection and central authority. These issues represent difficult internal Soviet political and economic questions. My opinion—as an external observer—is that the sooner you begin the reform process the better because no matter how swiftly you intend the necessary reforms to be implemented, they will take longer. There is little doubt you will encounter major economic disruptions as well as serious unexpected difficulties. These may produce serious civil pressures and cause segments of the Soviet public to call for a return of the old order. But, such reactions would be foolhardy—the old order was without hope and brought about today's conditions. More than one-third of your population earns less than 100 Rubles per month and the average monthly wage is only 250 Rubles—the price of ten packs of American cigarettes on the Black Market.

Clearly, the old order is no answer. Your only hope is that from the strife of the coming years will emerge a new Soviet world based on the precepts of individual freedom and a market-driven economy. And although your task will be arduous and will take many years, you have the resources to be successful. Your first and foremost resource is the people of Russia. For a nation that gave birth to Tolstoy, Dostoyevsky, Pushkin, Gorky, Borodin and Tchaikovsky is a nation of an immensely rich and resourceful culture, one that has the depth of talent to lead toward economic victory. Indeed, the Soviet Union has endured much misery in its history, but it has persevered. And it can persevere this challenge as well.

Certain of Russia's most admirable characteristics will need to be redirected in the process of moving toward a market economy. Your spiritual soul will need to develop a somewhat materialistic counterpart. As author Hedrick Smith recently wrote: "Perestroika has to happen in the mind for it to work. People's outlooks have to change and that happens as society changes. It is a push-pull, gradual process. It cannot be decreed."

At this juncture, however, it is critical for your leaders to concede their differences, compromise divergent points of view, build upon their basic agreements, and assist your nation in achieving common objectives. Indeed, the greatest disservice to the Soviet Union at this time is for divisiveness among the leadership to detract you from the goal you seek. Therefore, urge your leadership to embrace common goals and join hands to lead your nation on the road to a market economy.

Along the way, you will need to build futures and options markets, for these markets are without substitute in providing a mechanism for price discovery. They are an open forum where market participants—buyers or sellers, producers or consumers, investors or speculators—have the ability to direct their price opinion on the value of the product to the auction process. Through this process, a fair price for the product is discovered. And for that moment in time, until the next set of variables change the price, value is established. No other mechanism can boast a more certain avenue at determining value than the futures and options markets.

Price discovery is but one function of futures and options markets. These markets are ideally suited for the transference of risk (hedging) as well as for capitalizing on profit opportunities. In the world of today—where innovation and competition will intensify, where demand for tailored risk management strategies will increase, and where opportunities will rapidly appear and disappear on a constantly changing financial horizon—few forums serve the needs of the financial community better than futures and options markets. Indeed, no markets other than futures and options offer a blend of so many credible instruments to safeguard or strengthen one's assets.

Today's established futures and options markets offer the widest array of agricultural and financial instruments—in virtually every center of finance—from beans to bonds, from cattle to crude, from stocks to silver, from gilt to gold, from euros to yen, from coffee to the CPI. These markets offer a measure of liquidity not available elsewhere; a cost-efficiency of incomparable narrow bid/ask spreads; an ability to swiftly institute a variety of strategies, programs, or fine-tuning techniques; the ability to cost-effectively adjust portfolio exposure; a flexibility to choose between the most fairly-priced alternative instrument at any time; a facility to preserve credit lines within a system offering the highest degree of credit-worthiness; a fluency to access all markets on a global basis; a speed and certainty of execution difficult to duplicate; and soon, market coverage on a 24-hour basis. These aspects of futures and options—their price discovery apparatus, their hedging ability, and their profit potential—have made these instruments integral to the infra-structure of global finance and indispensable to a market-driven economy.

Finally, GLOBEX—the newest addition to the revolution sponsored in Chicago in 1972—will again revolutionize the markets of the world. GLOBEX is an electronic trading system currently being developed between the Chicago Mercantile Exchange, the Chicago Board of Trade, and Reuters Holdings PLC— the world's largest international market telecommunications entity. When GLOBEX becomes functional, it will allow all our American futures and options products to be traded worldwide on a 24-hour basis. It will also allow all the major futures markets to participate with their unique product line. Indeed, the MATIF, the Paris-based futures exchange which is today number one in Europe, is already a partner to this system. Ultimately, GLOBEX will be the central trading system for all the world's futures and options markets. And, in the future when the Soviet Union is well along in its free market journey, the Moscow Commodity Exchange may also become a proud member of the GLOBEX family of world futures exchanges.

Until that day, allow me to congratulate you on the momentous step you have taken in opening the doors to the Moscow Commodity Exchange. On behalf of all the members of the Chicago Mercantile Exchange, best wishes. We stand ready to assist you in every way possible.

Reprinted by permission. Excerpted from Melamed on the Markets, by Leo Melamed. John Wiley & Sons, 1993

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